ECB could announce stimulus scale-back as soon as next month

AP News
Posted: Sep 07, 2017 11:40 AM
ECB could announce stimulus scale-back as soon as next month

FRANKFURT, Germany (AP) — The European Central Bank could be ready as soon as next month with plans to finally start scaling back its extraordinary stimulus efforts as the eurozone's economy gathers speed.

President Mario Draghi said Thursday that the bank is reassessing the bond-buying program, which is credited with boosting growth by reducing borrowing rates, and could announce changes as early as next month.

At a press conference after the bank's 25-member governing council decided to leave its interest rates and bond-buying program unchanged, Draghi said the ECB will soon decide on the "calibration" of its policy instruments beyond 2017.

"We think we are going to be ready for much of what we have to decide in October," said Draghi. "If we are not, then we postpone."

Investors took Draghi's statement as a hint that the bank may outline a strategy on reducing its monthly asset purchases at its Oct. 26 meeting. The euro jumped 0.9 percent to $1.2022.

Strong economic growth in the eurozone has ratcheted up expectations that the bank, which sets interest rates for the 19 countries that use the euro, will soon start to phase out its bond-buying program. The stimulus involves the bank purchasing 60 billion euros ($72 billion) of bonds a month in the markets in order to keep interest rates low and get inflation up to its goal of just under 2 percent, a level considered healthy for the eurozone economy. While growth has picked up to 0.6 percent in the second quarter, annual inflation in August was still only 1.5 percent.

Phasing out bond purchases would begin the withdrawal of stimulus measures aimed at overcoming the aftershocks of the Great Recession and the eurozone's crisis over high bank and government debt. The economy has shown steady growth since the second quarter of 2013 but suffered through a stretch of low, even subzero, inflation that raised fears of a chronic downward spiral in wages and prices. Draghi says that danger is now over.

Draghi said, however, that a "very substantial" degree of support from monetary policy was still needed for the time being. He has been reluctant to spell out the timing and pace of the phase-out of the bond purchases for fear of sending the euro and market interest rates higher ahead of the fact. That kind of market reaction would blunt the impact of the stimulus before it has run its full course.

The euro's recent rise has complicated the ECB's mission, as the stronger currency can hurt eurozone exports and lower inflation. On the currency, Draghi said the recent exchange rate volatility, which has seen the euro rally about 15 percent this year to breach the $1.20 mark for the first time in two and a half years, "requires monitoring" and is a source of "uncertainty."

Though not a specific target, Draghi said the exchange rate is "very important" as it affects the rate of inflation, the bank's chief policy concern.

"Step by step, the European Central Bank is heading for the exit from its aggressive stance," wrote Holger Schmieding, chief economist at Berenberg Bank in London, in an email. "But to which extent the ECB will reduce its asset purchases at the beginning of 2018 will depend on the exchange rate of the euro."

Schmieding predicted the ECB would announce on Oct. 26 that it will cut the bond purchases from 60 billion euros to 45 billion euros starting in January, and make further reductions every three months if growth and inflation stay on track.

The course of the euro depends on several factors, including decisions by the U.S. Federal Reserve. The Fed has ended its own bond purchase stimulus as the U.S. recovered faster than Europe from the Great Recession. Faster than expected rate increases from the Fed could help drive the dollar higher and the euro lower.

The euro's strength appears to be the main reason behind lower inflation projections from the ECB. It now expects inflation to be 1.2 percent next year against 1.3 percent previously and to be 1.5 percent in 2019 from 1.6 percent. However, it raised its economic growth forecast this year to 2.2 percent, which would be a ten-year high, from 1.9 percent previously.

An end to the stimulus would have wide-reaching effects on markets, companies, governments and consumers. Long-term interest rates would rise for borrowers such as governments, leaving less for spending on other things, and for people with house mortgages. Savers might see appreciable returns on their holdings, currently scanty due to the zero-interest rate policy. Higher rates could mean trouble for so-called "zombie" companies that would no longer be profitable if they had to pay more normal rates for credit; their departure from the economy through bankruptcy, however, could free resources for more productive uses.

The bond purchases, which began in March 2015, have pumped newly printed money into the banking system, lowering long-term interest rates and making credit more easily available.

The purchases are set to run at 60 billion euros per month through the end of the year, and longer if needed to raise the inflation rate.

To further help the economy, the ECB left its benchmark short-term interest rate at zero, and its deposit rate at negative 0.4 percent, both record lows.